The compound interest is the interest on the principal amount which is added back to the principal to calculate the interest for the next period.
This process of adding the interest of the previous period to the principal continues till the maturity.
See the screen shot:
You can see the in above screen shot that when $ 10,000 are invested at the rate of 5% per year, the first-year interest is $ 500 and this interest is added back to the principal $ 10,000.
This process is repeated till the maturity period of 10 years.
The compound interest formula in Excel is generally used to calculate the future value of the investment with the given time-period and the rate of investment.
The value of n:
Let us understand with the help of an example:
Let’s say I deposit $ 10,000 (one-time investment) for 10 years at the annual rate of 5% with yearly compounding.
Solution: To calculate the Maturity value in Excel, use the following formula:
So, my investment will become $ 16,288.90 at the end of the 10th year.
Many a times, this formula will give you the output with many digits after the decimal. Just use the Round function to limit the digits to 1 or 2 after the decimal.
The new formula becomes:
The maturity amount varies with the change in the number of compounding period. I can say that the maturity amount increases with the increase in the number of compounding periods.
In the above example, if I change the nature of compounding from yearly to quarterly (4 compounding periods in a year), my maturity amount increases to $ 16,436.20.
The Excel formula becomes: